The Legacy of the Crash

by Terrence Casey

  Where does this all leave American and British society? Obviously much depends on the future course of the economy, and nothing would solve these problems quicker than a good run of above average GDP growth. Given the impasse over the US federal budget and the lingering sovereign debt crisis in the euro zone, a second serious downturn is possible, although policy-makers are more attuned to the dangers now. With the weight of public and private debt, the more probable outcome is an extended period of sluggish growth. To foretell what this might mean for our societies, one need only look to Japan, where a ‘Lost Decade’ (initiated by the bursting of a property bubble, no less) metastasized into ‘Lost Decades’, with no end in sight. The Japanese post-war ‘economic miracle’ was built upon legions of dedicated ‘salarymen’ working relentlessly for major corporations in exchange for lifetime employment. Years of economic stagnation have corroded this system, with many Japanese companies downsizing their permanent workforce and replacing them with temporary or part-time workers. Younger workers bear the brunt of these changes. After years of diligent work in school and university, they face a world of bleak employment prospects. In 2010, one in five Japanese university graduates failed to find full-time employment (CBC News (Online), 8 October 2010). Without permanent employment, possibilities for marriage and family dwindle as well. Japan is now experiencing its second ‘Lost Generation’ whose economic and social prospects are worse than their parents. The parallels with Japanese experience are certainly imperfect. They face the challenge of an aging and shrinking population, as well as the innate conservatism of many Japanese institutions. That ‘lost’ has become such a ubiquitous adjective in describing the Japan, however, is a worrying portent of what could happen to our societies should long-term stagnation set in.

  The debt challenge

  The post-crash economies in both states are faced with two great challenges; the first being the debt crisis, which is actually the concurrent problems of public and private (mainly consumer) debt. The trick is to resolve the public debt problem without exacerbating private debt. Politics in both nations are now intensely focused on deficit reduction, with the coalition focusing on substantially cutting the deficit within the terms of this parliament with the hope that this will increase market confidence, spending, and investment. Success, if it happens, is still some years off ,while the pain of budget cuts is hitting hard and fast. The Lib Dems are fully on board for now,8 but the details may yet strain the coalition. In the US, under current budgetary guidelines the public debt will be reaching 100 percent of GDP by the end of the decade. While both major parties express a desire to reduce the deficit, an ideological gulf remains, with Democrats insisting on raising taxes (although only on ‘the rich’) and Republicans demanding greater spending cuts (while assuring voters that entitlement programs will be protected). In summer 2011 the Republicans drew a line in the sand, demanding that raising the debt ceiling must be connected to serious deficit reduction. At the time of this writing, negotiations are ongoing.

  The details of competing debt reduction plans need not concern us here. The key point is that fiscal necessity is pushing both Washington and London to look much more seriously at reducing the size of the state (even if not stated so bluntly) than at any point since the 1980s. What is immediately striking is that the debate is not whether government spending needs to be reduced, it is about the relative distribution between spending cuts versus tax increases. Budget-cutters so far seem to have the edge. In Britain, where the opposition Labour Party can do little more than verbally oppose these cuts, Cameron’s government has staked its re-election prospects on the success of this strategy. With divided government in Washington, the situation is more muddled, although the ratios of difference have narrowed and moved more toward the Republican side, provoking disenchantment among liberals with Obama. There is an enormous distance between cuts proposed and cuts made, and the path is strewn with political landmines. Still, the debate is pushing in what is thought of as a more conservative direction. Assuming that trends continue, we may see the ironic result that the global financial crisis, billed by so many as the end of neoliberalism, will serve to realize one of the original yet unfulfilled promises of neoliberalism – to reduce the size of the state.

  When it comes to private debt, there is some divergence between the US and UK. The last ten years saw a sharp rise in consumer debt, peaking in 2007 at 183 percent of disposable income in the UK and 138 percent in the US.9 Both numbers have fallen since, but the UK Office of Budget Responsibility (OBR) projected in early 2011 that household debt would again rise to 173 percent of disposable income by 2015. At the same time the financial obligations ratio (the ratio of debt payments to disposable income) compiled by the US Federal Reserve fell from its peak of 18.8 percent in the second quarter of 2007 to 16.6 percent at the end of 2010, similar to where it was in the early 1990s. The Fed shows that while non-revolving consumer credit, especially student loans, demand is rising; demand for revolving credit, such as credit cards, is falling (Bloomberg (Online), 7 April 2011). UK consumer debt, having dropped off after the crisis, is heading back up while the downward trend in the US has not yet bottomed out. Nevertheless, growth requires consumption and excessive debt burdens get in the way. Reducing the levels of debt (public and private) in the economic system is a prerequisite for renewed growth. The open question is, if household debt continues to rise, will consumption be stifled as consumers focus their money on debt servicing rather than new consumption?

  A new growth model?

  The second great challenge, intimately related to the first, is how to revive growth. From the early 1980s, the neoliberal economic model reigned supreme, emerging from its Anglo-American heartlands to colonize much of the globe. The financial crisis produced obituaries that were swift and unequivocal: ‘the Anglo-liberal growth model is irretrievably and irreversibly compromised’ (Hay, 2010a, pp. 25–6.); ‘neoliberalism has self-destructed’ (Mykhnenko and Birch, 2010, p. 255); ‘The current crisis, and the responses to it, seem to have delivered a death blow to neo-liberalism’ (Fine, 2009, p. 1). The death of the king, of course, usually signals the coronation of a new monarch. As noted in Chapters 3 and 7 above, however, alternative modes of economic governance are noteworthy in their absence. It should also be remembered that, ‘After the trauma of Black Wednesday and the exit of the pound from the exchange rate mechanism (ERM) in 1992, the British economy grew steadily and uninterruptedly for the next 16 years, the longest sustained period of growth in modern history’ (Gamble, 2009b, p. 450). The US record was similar, albeit with a brief downturn in the early 2000. The free market may have crashed spectacularly in 2008, but it had delivered the goods for many years prior, complicating arguments for replacing it. Neoliberalism’s detractors dismiss the boom, though. In effect, the entire neoliberal era is treated as a bubble, with growth exaggerated by the inflated values of artificially created financial assets rather than real economic gains. With flat wages, consumption was maintained through rising personal indebtedness, while the rentier class collected the bulk of the gains for themselves. For critics, neoliberalism was nothing more than a gilded house of cards.

  Comparative perspective is useful in assessing this claim. Particularly for the British economy, the Keynesian era was also one of absolute gain but relative decline. With the switch to neoliberalism, both economies saw improved relative performance on output and employment. British per capita GDP over the last 50 years is marked by a distinct U-curve compared to Germany and France: declining throughout the Keynesian years and reviving after 1980.10 Even on productivity, Britain’s traditional weakness, although it still lags behind, the gap narrowed in the 1990s and 2000s.11 Starting from a dominant position, America saw other major industrialized powers, particularly Germany and Japan, catching up on income and productivity for the first three decades after the Second World War. Those trends stabilized in the 1980s, reversing course (albeit well below the post-war supremacy) from the 1990s onward. As the mos
t recent recession was a global affair, the downturn in the Anglo-Saxon economies were matched by recessions elsewhere, even if not of always equal magnitude. It is thus not yet clear if the current downturn is indicative of a change in trends in relative performance.

  The crash of 2008 certainly wiped out some of the economic gains made to that point, but it did not negate all that came before it. To this end one must distinguish between the drivers of growth in different periods. Policies in the 1980s are best characterized as ‘shock therapy’ (Fine, 2009); breaking the market impediments of the Keynesian era. Both the US and UK saw improved growth rates, followed by economic overheating and a recession in the late 1980s and early 1990s. Growth in the 1990s rested on a salubrious combination of expanding developing markets, the costs advantages of increasingly globalized production, and the productivity boost delivered by a new wave of information technology. The last decade, however, saw diminishing returns to both globalization and technology. Combined with a recession, the disruption of 9/11, and the challenges of two wars, there was great potential for an extended slowdown. In this environment policy-makers chose the easy option of boosting output via loose credit and fiscal stimulus, even if not explicitly recognized at the time. Americans saw taxes cut, domestic spending increased, and a house price boom due to low interest rates. The UK followed suit, albeit without the tax cuts and with proportionally much higher spending increases. Low unemployment in the latter New Labour years was brought about by a vast increase in public sector jobs (Froud et al., 2011). Overall, growth in the decade was fueled by debt, both public and private. To simplify the point, the 1980s were a period of neoliberal transition, the 1990s an era of ‘good growth’, and the 2000s a decade where policy-makers relied on a quick, easy, but ultimately unsustainable growth formula. From this perspective, rather than seeing the crash as the inevitable outcome of the model, the crisis resulted from financial excesses exacerbated by ill-considered public policy. It was a crisis within neoliberalism rather than a crisis of neoliberalism.

  This is hardly an uncontested argument. Colin Crouch (2009) describes neoliberalism as a system of ‘privatized Keynesianism’. Capitalism suffers from a paradox: profitability requires labor flexibility, rendering workers less secure and confident consumers, and undermining profitability. The post-war Keynesian model smoothed the business cycle and protected vulnerable workers through the extension of the welfare state. State spending in democratic systems ratcheted ever upward, however, creating inflationary pressures and undermining growth. In Crouch’s depiction, Thatcher and Reagan did not really alter the economic model; they merely shifted the locus of growth financing.

  two things came together to rescue the neo-liberal mode from the instability that otherwise would have been its fate: the growth of credit markets for poor and middle income people, and the derivatives and futures markets among the very wealthy. This combination produced a model of privatized Keynesianism … Instead of governments taking on debt to stimulate the economy, individuals did so. (Crouch, 2009, p. 390)

  Colin Hay echoes this idea in his portrayal of an ‘Anglo-liberal growth model’, adding that private debt-driven consumption required governments to keep property values rising (Hay, 2009, 2010). Rising private debt is thus transformed from an unfortunate outcome of misguided policies into a central tenet of the neoliberal model. If the Achilles’ heel of Keynesianism was a politically-motivated ‘spending ratchet’, the weakness of neoliberalism is a market-motivated ‘debt ratchet’.

  Neoliberalism’s sins thus transmute from omission to commission, with governments intentionally encouraging the growth of private debt to stimulate growth. The problem for this argument, for one, is that it extrapolates the trends of 2000s to the entire neoliberal era. The key causes of the crisis – the housing bubble, fed by subprime mortgages and spread through securitization – were not occurring (or only just beginning) in the 1980s and 1990s. Nor does ‘privatized Keynesianism’ take seriously that financial liberalization could have developed along any alternate and more economically stable path. Take a simple counterfactual: What if the US Federal Reserve had raised interest rates much earlier? Permissive monetary policy was a prerequisite for the crisis. More effective macro-economic management could have averted, or at least ameliorated, the inflation of asset prices ceteris paribus. The Crouch and Hay argument is more exact as a description of events than as a theoretical construct. In fairness, though, this only handles part of their critique. Yes, sound macro-economic management might have avoided instability, but would it have come at the cost of reduced growth? If the contours of financial liberalization remain largely intact, can the Anglo-Saxon economies return to vibrant and sustainable growth?

  The question is whether the neoliberal model needs repair or replacement (Gamble, 2010, p. 13). One fix that has received new life, particularly from politicians on the right who are loath to critique the free market, is the need to rebalance the economy. Economic ‘imbalance’ has numerous meanings, relating to trade balances, fiscal deficits, excessive public spending, regional disparities, or sectoral issues, depending on the source (Froud et al., 2011, pp. 9–10). The latter is the most frequently cited and relevant here. We are said to have become overly reliant on the profits of financial intermediation to drive growth while manufacturing erodes – too much ‘trading paper’ and not enough ‘making things’. Germany, with its stable manufacturing and export base, is held as the exemplar of advanced country economic management in a globalized world. Politically this is an appealing moderate, reformist approach, yet it is likely a non-starter. Fundamentally this requires policies to divert investment out of the financial sector and into manufacturing. Governments on both sides of the Atlantic have attempted to revive declining manufacturing areas for decades with little success. Deindustrialization stems more from larger technological developments and shifts in the global political economy. Swimming against these tides is no more likely to work now than in the past. Nor will diverting funds from the financial sector – where both Wall Street and the City have an international comparative advantage – guarantee a concomitant increase in manufacturing activity. More to the point, for good or ill, the financial sector contributes substantially to economies of both states, especially in the UK. Despite the turmoil of recent years, it is once again a growing sector. It would be difficult to reduce the role of finance without harming the macro-economy in the short term. In a period when politicians’ fates hang on a precarious recovery, this seems a terrific gamble.

  Another path is to craft specific regulations that will prevent financial market excesses. Part I explored causes and responses to the crisis, which included a combination of new institutions and regulations, such as the new US Consumer Finance Protection Bureau, and establishing means of ‘macro-prudential’ surveillance. Will these be enough to prevent a future meltdown? Analysis of that question is a book unto itself and as these changes are still being finalized and implemented, their full impact has yet to be revealed. The larger question is whether they were properly focused and get to the heart of the potential for economic revival with a neoliberal political economy. The fundamental rationale for liberalizing financial markets is to more effectively funnel capital into productive investment, increasing economic output. The major argument against unregulated financial markets is that it creates incentives for highly leveraged, speculative activity that enhances financial firms’ profits without adding to the ‘real economy’. Will the financial sector, undisciplined by a reformed regulatory framework, avoid again being drawn into another speculative bubble and guide capital into productive investment? Or are the incentives faced by the ‘electronic herd’ so great that they cannot help but get drawn in by the huge payoffs promised by increasing leverage and speculation? Can relatively unregulated financial markets in this sense be ‘socially efficient’ (or are the new regulations enough to make them so)? Can these systems both return to the long-term trend rate of growth while avoiding financial destabilizatio
n? These are the most important questions in considering the future of the Anglo-American political economies. They are also, unfortunately, incredibly difficult to answer. The answers rely, after all, on developing non-subjective distinctions between ‘speculative investment’ and ‘productive investment’, for example. Is Facebook a productive investment? Are profits made from trading derivatives socially useless speculation if they have the result of increasing the value of many individuals’ retirement accounts?

  Finance plays a basic role in modern economies. To use an anatomical analogy, it is the ‘cardiovascular system’ pumping needed capital to the rest of the body economic. After years of unhealthy living (leveraged speculation), it suffered a massive coronary in 2008. The question is whether the patient has learned the lesson. Will those markets, working within the constraints of post-crash regulations, serve as effective intermediaries for guiding productive investment, or will they plunge into another bout of speculative excess? At the moment the answer to this question is disquietingly indeterminate.

  For those who see venal financiers as the chief culprits responsible for our current woes, this is an unsatisfactory answer. Previous crises ushered in periods of ideological polarization and contestation, producing new political-economic orders. But ideological polarization requires that there be ideological poles. The most stunning intellectual development since 2008 is that those looking for alternative economic models to counter the free market model have been met with deafening silence. Certainly there has been a renewed interest in Keynesianism, yet the nostalgia for Keynes comes more as a form of triage, a way to prevent further decline, than a foundation for future prosperity. The crisis also presents an opening for advocates of green development, which has a certain intellectual appeal, but not much of an electoral appeal in the US or the UK.12 The promise of environmental sustainability without any trade-off in material standards of living remains elusive. Previous crises of capitalism all had counter-movements waiting in the wings for some years, poised with argument and organization. For the intellectual hegemony of neoliberalism to be dislodged, a counter-hegemonic framework must first be developed that speaks directly to our current problems, appeals to the electorate, and offers some reasonable prospect of reviving economic performance. None has yet to emerge, at least none that has resonance outside of university faculty lounges. We are thus most likely to see the development of a new phase of neoliberalism, not its elimination (Gamble, 2009b, p. 461). The open question is whether this neo-neoliberalism will, after some years of retrenchment, return Britain and America to prosperity.